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SEC Eases Auditor Independence Rules for Private Equity (1)

Oct. 16, 2020, 4:22 PMUpdated: Oct. 16, 2020, 5:50 PM

The SEC issued a final rule package Friday that relaxes the threshold for the types of relationships and lending activities that could violate strict conflict-of-interest rules by swaying an auditor’s objectivity.

Approved in a 3-2 vote, the rule changes specifically target relationships among auditors and their clients that are held in funds like private equity portfolios, along with a set of changes designed to clarify when auditors’ personal banking and financial decisions may also impair their independence.

Despite the revisions, key aspects of the Enron-era rules remain, including the list of services that firms can’t provide to audit clients and the expectation that auditors must be independent in fact and appearance.

Securities and Exchange Commission officials said the updated rules would ensure that companies and investment company complexes don’t have to change auditors simply because of a technical or minor violation of the rules—effectively increasing the number of qualified firms that an issuer can chose among. The rules would also reduce the time-consuming work of tracking conflicts of interest among a complex web of companies, auditors, and consultants that often span the globe.

“These modernized auditor independence requirements will increase investor protection by focusing audit clients, audit committees, and auditors on areas that may threaten an auditor’s objectivity and impartiality,” SEC Chairman Jay Clayton said in a statement.

In a dissenting statement, Commissioners Allison Lee and Caroline Crenshaw said the rule changes give auditors too much discretion to decide whether or not they complied, will result in uneven application, and ignore the needs of investors.

“These rules are most useful when they draw clear lines, so that both auditors and investors know exactly what to expect when it comes to the critical issue of independence,” they wrote. “Today, however, a majority of the Commission is continuing the trend of blurring these lines and introducing uncertainty into a calculus that benefits greatly from clarity.”

Efforts to loosen those standards in the U.S. are contrary to efforts by regulators in other countries who are considering conflict-of-interest reforms, they wrote.

The private equity industry supported the proposal but said previously it wouldn’t eliminate the burden of evaluating each company held in a portfolio and any possible overlap between auditors and consultants for the dozens, or hundreds of companies in each fund.

Interpreted strictly, the previous conflict-of-interest rules meant that an accounting firm couldn’t both audit one of those portfolio companies and provide payroll or appraisal services to others held in the same portfolio. A single consulting project at an affiliate company overseas could be enough to trigger the U.S. rules.

The just-approved changes formalize guidance that the SEC has repeatedly doled out through phone calls and individual cases for roughly two decades that such minor infractions don’t violate the intent of the rules, SEC officials said.

Among the changes, the revised rules:

  • Add a materiality threshold to determine whether a company is considered an audit client for portfolio and investment companies.
  • Set a compliance window to address independence violations following a merger or acquisition
  • Shorten the look-back period for domestic, first-time filers to review independence compliance
  • Revise the business relationship rule by replacing the term “substantial stockholders” with “beneficial owners who have a significant influence over the audit client.”

Companies and audit firms have 180 days to prepare for the rule changes after they are published in the Federal Register. Early adoption is permitted.

(Adds commissioner dissent, more details about the rule scope, effective date beginning in paragraph five. )

To contact the reporter on this story: Amanda Iacone in Washington at

To contact the editors responsible for this story: Jeff Harrington at; Kathy Larsen at